Why Google Fiber Is a Big Deal to Microsoft and Comcast

Google unveiled that it was considering expanding its Fiber business to 34 new cities spanning locations from Atlanta, GA to San Jose, CA. This service offers three tiers of service, with one tier offering basic Internet service for free after a relatively small investment. Needless to say this service could be a big deal for Google, but it has the potential to disrupt Microsoft and Comcast in particular.

Fiber could make this $45 billion merger worth lessWhen Comcast announced it would buy Time Warner Cable for $45 billion the potential effects could be felt across the country. Comcast has about 22 million video customers and Time Warner has roughly 11 million. With 19 million high-speed Internet users at Comcast and roughly 11 million at Time Warner, a large portion of the U.S. would be covered by one company's Internet and video operations.

Considering the combined company would have generated over $9 billion in core operating cash flow (net income + deprecation) in the last three months, we are talking about a very significant company indeed. The combined company would have about 30 million high-speed Internet customers. However, what if Fiber were able to steal just 1% of this customer base?

According to a recent study, Fiber generates about $47 a month in contribution profit for Internet-only households and $64 a month if the customer chooses both Internet and TV service. With just 1% of 30 million, Google would gain 300,000 households. These households would produce between $169 million and $230 million per year in contribution profits.

At a 5% rate, Google would have about 1.5 million customers generating between $840 million and $1.1 billion per year in contribution profit. Considering Google generates about $3 billion a quarter in free cash flow -- at an estimated $100 million per city-- the company can afford a lot of Fiber.

The point is, Comcast needs to take this threat very seriously. A study last year showed Time Warner Cable ranking dead last in customer satisfaction, and Comcast ranked in the bottom ten. Google Fiber could be an easy way for these disgruntled customers to leave Comcast.

This struggling business could be about to get even worseUnfortunately for Microsoft, the expansion of Google Fiber could mean that the PC business will get even worse. One of the challenges facing the mass adoption of devices like Google Chromebooks is the fact that they need an Internet connection to work.

However, Fiber should theoretically drive higher Internet adoption rates. With more high-speed Internet comes more Wi-Fi usage and thus Microsoft's argument against using a Chromebook loses a lot of its punch. Microsoft reported a 3% annual decline in the company's OEM Windows business. It's possible that as Fiber expands the PC business will suffer steeper declines.

In a similar manner, the expansion of Google Fiber could lead to higher levels of tablet adoption. Microsoft still maintains a better than 90% market share in PC operating systems. However, Apple's iOS and Google's Android OS dominate the mobile landscape. While Microsoft has improved its Surface sales (revenue doubled last quarter), the company's tablet business is barely a blip on Apple and Google's radar.

Bad for BingMicrosoft's Bing search engine seems to be doing well. In the current quarter, the company reported that search market share increased, and advertising revenue increased by 34%. Given that Google's paid clicks increased by 31%, this looks very respectable.

The bad news is, for every Google Fiber customer they are going to get a Google-flavored version of the installation. In other words, when Google connects the user to Fiber, the idea that Google's search engine, YouTube, Google Docs, and other properties won't be heavily promoted is impossible to conceive.

In the same way that Comcast helps customers set up their Internet service, by giving them a Comcast email, and many times a Comcast search bar on their browser, Google would be crazy not to try the same thing. Though Google already dominates the domestic search business, every installation of Fiber will likely cement that lead.

Foolish final thoughtsWhile it's true that Fiber may not come to all 34 cities, for every city it does infiltrate there will be winners and losers. Customers are the ultimate winners as Fiber makes Internet service more affordable for some, and brings more choices for everyone.

Unfortunately, for Comcast and Microsoft investors, Fiber could be yet another threat to their core businesses. It would be foolish (small f) to think otherwise.

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